Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. No. 03 C 1174-Amy J. St. Eve, Judge.
The opinion of the court was delivered by: Easterbrook, Chief Judge
Before EASTERBROOK, Chief Judge, and BAUER and WOOD, Circuit Judges.
When the accounting firm Arthur Andersen was indicted in the wake of Enron's collapse, it lost most of its clients. Active accountants could move to other firms, whose business boomed after the Sarbanes--Oxley Act compelled firms to purchase more accounting services than ever before. Retirees, however, were in trouble, for Arthur Andersen's pension plan was unfunded. Although ERISA requires plans within its scope to be established as trusts and funded either fully (for defined-contribution plans) or according to a formula (for defined-benefit plans), the statute covers only plans for "employees." Arthur Andersen treated its senior accountants as "partners" rather than "employees" and thus as outside of ERISA.
For many years Arthur Andersen capitalized the retirees' benefits and disbursed lump sums on request. (Whether that was the retirees' contractual right, or just an accommodation that the firm was free to discontinue, was hotly disputed but is not pertinent now.) With the firm's collapse looming, retirees en masse demanded lump-sum distributions. That created the equivalent of a run on a bank. If Arthur Andersen paid 100% to the retirees who got in line first, the rest stood to receive nothing. If it stopped all lump-sum distributions, then it might be able to pay some portion of all retirees' claims-and perhaps more in the aggregate than it could distribute if it followed a first-come, first-served policy. So Arthur Andersen told its retirees that it would continue monthly pension payments but would not honor any requests for lump-sum distributions, though it would explore the possibility of cashing out all retirees at a reduced level.
Litigation ensued. The first two complaints were filed in March 2002. The parties call that litigation the Buchholz/ Bryce proceeding after the two lead plaintiffs. They alleged, among other things, that the retirees had been employees rather than partners, that ERISA therefore required retirement benefits to be funded through a trust, and that Arthur Andersen is liable for breach of this statutory duty. Those claims potentially came within the scope of insurance policies such as the one issued by Federal Insurance Co., which covered negligent or deliberate breach of fiduciary duties owed to retirees. In May 2002 Arthur Andersen's insurance broker first informed Federal Insurance about the Buchholz/Bryce litigation. The letter told Federal Insurance (and several other insurers) about the suits, stated that Arthur Andersen had retained Mayer, Brown, Rowe & Maw (now Mayer Brown LLP) to represent it, and directed the insurers to deal with Arthur Andersen on this matter through the broker rather than through Mayer Brown. The broker did not ask Federal Insurance to provide a defense (Mayer Brown already was doing that) but did ask it to "confirm coverage" and chip in toward the cost of Mayer Brown's services. Federal Insurance replied within a week that it was reserving its rights, and it asked for a copy of the partnership agreement (so that it could evaluate the plaintiffs' claims) and a schedule of Mayer Brown's rates.
Follow-up requests were unavailing until August 2002, when the broker finally provided Federal Insurance with the information-plus the news that the Buchholz/Bryce complaint had been dismissed by the plaintiffs, who (the broker said) planned to inaugurate arbitration instead. Since there was neither a suit nor an arbitration pend-ing-at least none of which Federal Insurance had been notified-nothing happened for the next month.
In September 2002 the broker told Federal Insurance that there was indeed another complaint, the Waters suit, which had been filed in a California court in July 2002. Once again the letter did not request a defense but did ask Federal Insurance to consent to Mayer Brown's role as Arthur Andersen's lawyer. In November Arthur Andersen proposed a compromise to all retirees and wrote to its insurers that it needed at least $75 million from them to fund a settlement; it asked Federal Insurance to pay the policy limit of $25 million. But Federal Insurance had read the Waters complaint and learned that it did not make any claim that Arthur Andersen (or any of its managers) had acted negligently or breached any fiduciary duty. Waters was a pure contract action: the complaint asserted that every retiree was entitled by contract to immediate distribution of retirement funds. Federal Insurance's policy excludes claims for retirement benefits due under contracts, and it told Arthur Andersen that it would not contribute toward a settlement fund. In January 2003 Arthur Andersen settled with most retirees for $168 million (the rest settled in 2006 for a further $63 million), a fraction of the outstanding retirement balances.
When Federal Insurance filed this diversity action in February 2003, seeking a declaration that it was not required to defend or indemnify Arthur Andersen, it was met with a response (and counterclaim) seeking indemnity not only under the policy's terms but also on a theory of estoppel because of failure to participate in the defense of the suits. The district judge wrote a comprehensive opinion, 2005 U.S. Dist. LEXIS 15706 (N.D. Ill. Aug. 2, 2005), that reached two fundamental conclusions: first, the policy did not require Federal Insurance to indemnify Arthur Andersen for payments to the retirees, but, second, its failure to provide a defense coupled with its delay in filing the declaratory-judgment action might require it to pay anyway, as a matter of Illinois law (which the parties agree supplies the rule of decision).
A jury trial was held. The jury decided that, for the most part, Federal Insurance's delay was justifiable, but that it should have acted earlier with respect to the Waters suit and some other retirees' actions. After trial, the district judge granted judgment as a matter of law, see Fed. R. Civ. P. 50, in favor of Federal Insurance with respect to everything other than the Waters claim, because the additional matters on which the jury found against Federal Insurance had not begun until after February 2003, and Federal Insurance could not have been deemed to tarry unduly concerning those.
Federal Insurance was ordered to pay Arthur Andersen approximately $5 million to cover the cost of settling the claims of the retirees who had joined in Waters; otherwise judgment went in favor of Federal Insurance. Both sides have appealed. We take up the Waters claim first, because if Federal Insurance prevails on that claim it wins everything else too.
Like the district court, we conclude that the policy does not call for indemnity. It defines as a covered loss any injury caused by negligence or a breach of fiduciary duty. The retirees were not injured in that way; their problem stemmed from Arthur Andersen's business and legal difficulties. (The firm ultimately prevailed in the criminal prosecution, see Arthur Andersen LLP v. United States, 544 U.S. 696 (2005), but never recovered in the market.) In bank-run situations, a fiduciary does exactly what Arthur Andersen did: it defers payments so that all creditors can be treated alike and may receive a higher percentage of their investments than would be possible if the fiduciary liquidated assets on short notice to pay the early demanders immediately and in full.
The policy's exclusion for pension benefits also applies. Even if, as Arthur Andersen insists, the firm had a right to reduce or eliminate the benefits, the fact remains that the settlement reflects the present value of the pension promises (less a haircut reflecting Arthur Andersen's business distress) rather than damages for anyone's misconduct. No insurer agrees to cover pension benefits; moral hazard would wipe out the market. As soon as it had purchased a policy, the employer would simply abandon its pension plan and shift the burden to the insurer. Knowing of this incentive, the insurer would set as a premium the policy's highest indemnity, and no "insurance" would remain. Illinois would not read a policy in a way that made it impossible for people to buy the insurance product they want (here, coverage of negligence and disloyalty by pension fiduciaries). See Level 3 Communications, Inc. v. Federal Insurance Co., 272 F.3d 908 (7th Cir. 2001) (Illinois law).
There is one more reason why Federal Insurance need not indemnify Arthur Andersen for what it agreed to pay the retirees. A clause in the policy commits Arthur Andersen not to settle any claim for more than $250,000 without Federal Insurance's "written consent, which shall not be unreasonably withheld." (The full text of this clause, and of the policy's other material terms, appears in the district court's opinion.) Arthur Andersen didn't ask for the consent or even the comments of its insurers; it presented the deal to them as a fait accompli. By cutting Federal Insurance ...